Investment Basics and Your Settlement Fund

This is a guest post by Patrick Collins of Schultz Collins Lawson Chambers, Inc., the firm we hired to advise us on how to handle Kazan Law’s pension funds, our charitable foundation’s funds, and that some of our partners hired to advise them on personal money management.

Let’s say that you have just received a check for $1,000,000. Depending on your family circumstances, here are some questions that you might have:

How much can I spend?

Where should I put the money?

How long will the money last?

The first question is the “budget” issue; the second question is the “how-much-risk-do-I need-to-take” issue; the third question depends on your budget decision and investment strategy.

A million dollars is a lot of money. Can it fund a lifestyle that requires a $4,000 monthly budget? Remember, each month you will need to increase the monthly budget by the rate of inflation in order to maintain your lifestyle. Also, if you put your money in a safe, principal-guaranteed, interest-earning investment like a U.S. Treasury Note or an insured CD, you will pay income tax.

In order to get a rough idea of how a “safe” investment strategy might perform, we assumed that $1,000,000 was invested in a portfolio of short-term (6 month) U.S. Treasury Notes starting January 1, 1994. At the beginning of each month, you receive a check for $4,000 plus an adjustment for the rate of inflation. Thus, on February 1, 1994, you go to the mailbox and open a check for $4,013. By October of 2013 the check’s face value has increased to $6,407 because it takes $6,407 to buy the same amount of goods and services today that $4,000 bought in 1994.

We graph the value of the $1,000,000 fund after accounting for taxes (20% rate), inflation, and monthly withdrawals through October of 2013:

Absent withdrawals, if the $1 million could be invested in a world with no taxes or inflation, it would grow to $1,851,880. The income tax bite reduces it to $1,637,496. Inflation reduces the purchasing power to $1,019,671. This is a particularly sobering insight—after putting you money in a safe investment for approximately twenty years, the future value after inflation and taxes just about equals what you started with. You kept the money safe but earned nothing. Furthermore, this is before you start to take out your monthly check! However, after withdrawing the monthly check from your portfolio, the account dwindles to only $122,209.

The chart suggests that if you are willing to (1) live on a modest monthly budget; and (2) spend down your nest egg over a twenty-year period, then you need not take much, if any, investment risk. For comparison purposes, we ran the same numbers at $5,000 per month withdrawal—the guaranteed interest and principal portfolio is fully depleted ($0.00) by January of 2012. So you ran out of money—two years too soon!

If you want to increase your monthly consumption budget; or, if you want to give a larger bequest to family, church, or charity, then you will probably need to take some investment risk. There’s no right or wrong—it’s up to you.

Of course, this example covers the period from 1994 through October 2013. It is not a guide to what might happen over the next twenty years. It shows, however, how hard it is to produce safe and substantial monthly income and keep the nest egg intact.

Bottom Line: A good monthly income from your settlement funds often requires that you put principal at risk; keeping principal safe often requires that you live on very little monthly income.

The posts provided by Schultz Collins Lawson Chambers, Inc. [SCLC] convey information on basic investment concepts. They are intended to facilitate prudent investment decision making. They should not, however, be the sole factor in making investment decisions; and, they are not intended to act as advice or recommendations for any specific investor. SCLC acts as Independent Investment Counsel and is a Registered Investment Advisor. It does not provide legal, accounting or tax advice; and the opinions expressed in the posts are solely those of SCLC. You can find additional information about SCLC, their personnel, and client services at www.schultzcollins.com.

FreemiumWorld is a technology blog targeted on serving to users to search out free and quite simple solutions to their everyday issues and problems. Here you can download free Software & Games, WordPress Themes & Plugins and you will also get all type of tutorials related to SEO, Blogging, Affiliate Marketing and lots more.